UNITED STATES DISTRICT COURT FOR THE DISTRICT OF COLUMBIA

UNITED STATES SECURITIES AND EXCHANGE COMMISSION,

Plaintiff, : I Case: 1:08-cv-00348 : Assigned To : Kennedy, Henry H.

BALLY TOTAL FITNESS HOLDING CORPORATION,

: :

Assign. Date : 2/28/2008 Description: General Civil

Defendant.

COMPLAINT

Plaintiff Securities and Exchange Commission ("SEC" or "Commission"), for its

complaint against defendant Bally Total Fitness Holding Corporation ("Bally" or "defendant"),

alleges:

NATURE OF THE ACTION

1. In connection with its accounting over a several year period, Bally violated anti-

fraud, reporting, record-keeping, and internal controls provisions of the federal securities laws.

As described below, Bally made materially false and misleading statements about its financial

condition in SEC filings and &other public statements from at least fiscal year 1997through

fiscal year 2003. These materially false and misleading statements portrayed Bally's financial

condition (its net worth) and its performance (its income) aibeing far better than they actually

were during the relevant period.

2. These misrepresentations about its financial condition and performance were the

result of Bally's employment of accounting methods that were not in conformity with generally

accepted..accounting principles ("GAAP"), and in at least certain instances, were fraudulent.

On November 30,2005, Bally filed its 2004 Form 10-K, which restated its previously reported

financial statements for the years ended December 3 1,2002, and 2003, and restated selected

financial data for the years ended December 3 1,2001, and December 3 1,2000. The restatement

acknowledged more than two dozen different accounting improprieties that materially affected

Bally's financial statements during the relevant period.

3. Those accounting improprieties, which included frauds, had a pervasive effect on

the accuracy of Bally's public financial statements. For example, Bally originally reported in its

2001 Form 10-K that its year-end 2001 shareholders' equity, or net worth, was positive

$513 million. In truth, Bally's year-end 2001 net worth -- once all of the accounting

improprieties were corrected -- was negative $1.3 billion. Simply put, Bally overstated its year-

end 2001 net worth by $1.8 billion.

4. Bally's overstatement of its year-end 2001 net worth was the result of Bally's

accounting improprieties, which prematurely recognized revenue and deferred recognition of

expenses. This enabled Bally to hide the enormous magnitude of its accumulated losses:

through year-end 2001, those losses were $1.8 billion. Bally's losses should have been reflected,

among other places, in Bally's retained earnings, or more precisely, in Bally's accumulated

deficit. Retained earnings represent a M s cumulative profits; accumulated deficit represents a t

h ' s cumulative losses. Although Bally's originally reported year-end 2001 accumulated deficit

was approximately $100 million, its actual accumulated deficit was $1.9 billion. The $1.8 billion

understatement of Bally's accumulated deficit represents the amount of losses Bally incurred, but

did not report, through December 3 1,2001.

5 . Bally's accounting fiauds and improprieties did not stop in 2001; they continued

through 2003. As a result, Bally understated its originally reported 2002 net loss before income .-

tax by $92.4 million. Bally also understated its originally reported 2003 net loss before income

tax by $90.8 million. In addition to being included in the annual Forms 1 0-K, these materially

false and misleading financial statements were also included in registration statements (and

amendments thereto) filed by Bally in 2001,2002, and 2003.

JURISDICTION

6. This Court has jurisdiction over this action pursuant to Sections 20@) and 22(a)

of the Securities Act [15 U.S.C. 5s77t@) & v(a)] and Sections 21(e) and 27 of the Exchange Act

[15 U.S.C. 3s 78u(e) and 78aal.

7. Defendant directly or indirectly made use of the means or instrumentalities of

interstate commerce, or of the mails, or the facilities of a national securities exchange in

connection with the transactions, acts, practices and courses of business alleged herein.

DEFENDANT

8. Bally is a publicly-held company organized in Delaware with securities registered

with the SEC pursuant to Section 12(b) of the Exchange Act. Until May 2,2007, Bally's:

securities traded on the New York Stock Exchange. On May 2,2007, before the market opened,

trading in Bally common stock on the New York Stock Exchange was suspended. On July 3 1,

2007, Bally filed for reorganization under Chapter 11 of the Bankruptcy Code in the U.S.

Bankruptcy Court for the Southern District of New York. On October 1,2007, Bally emerged

fiom the reorganization a .a privately held corporation.

STATEMENT OF FACTS

9. Each of Bally's accounting frauds and improprieties is described below.

Described first are those that principally served to overstate Bally's gross revenue, and thus

overstate Bally's net income (or understate Bally's net loss). Described next are those that

principally served to understate Bally's expenses, and thus overstate Bally's income (or .. -

understate Bally's loss). Described last are those that served to understate Bally's accumulated

deficit as of December 3 1,2001, and thus overstate Bally's net worth.

BALLY IMPROPERLY OVERSTATED ITS GROSS REVENUE

10. As further described below, certain of Bally's accounting improprieties had the

effect of improperly overstating Bally's income by recognizing revenue prematurely. Bally

generated revenue by selling gym memberships, personal training services, and nutritional

products. Bally improperly accounted for much of this revenue. For example, gym

memberships generated two types of revenue for Bally: (1) initial membership fees, also called

"initiation fees," and (2) monthly dues. Bally prematurely recognized revenue for initiation fees

and monthly dues. Bally also failed to conform to GAAP when accounting for revenue from

certain personal training services. Further, Bally sold packages that bundled together gym

memberships, nutritional products, and personal training services, but failed to comply with

GAAP in accounting for revenue fiom these packages.

Bally Fraudulently Overstated its Gross Revenue from "Initiation Fees"

11. Bally fkaudulently and prematurely recognized revenue fiom initiation fees. As

described above, part of the price of a Bally health club membership was a one-time initiation

fee. This initiation fee was either paid in full when amember joined or was financed over a

period of time, typically 36 months. Regardless whether the initiation fees were paid in full at

the beginning of the membership, or financed over time, GAAP prohibited Bally fiom

recognizing all the revenue fkom initiation fees immediately.

12. Instead, GAAP required that Bally recognize initiation fee revenue over the entire

membership life. This means that for members who maintained their memberships beyond the

financing period, or initial period of membership, Bally was required to defer initiation fee

revenue and recognize it over the estimated membership life, not over the term of the initial

period of membership. During the relevant period, however, Bally prematurely recognized its

members' initiation fee revenue over a period that was not only shorter than the estimated

membership life, but in most instances even shorter than the initial period of membership.

13. In 1997, Bally adopted the "deferral method" of accounting for initiation fee

revenue. The manner in which Bally applied the deferral method, howeve;, recognized initiation

fee revenue over a period that in most instances was even shorter than the term of the initial

period of membership and was not in conformity with GAAP. In 2003, Bally switched to what it

characterized as a "modified cash method" to account for initiation fee revenue. However, Bally

also applied the modified cash method in a manner not in conformity with GAAP and as a result

recognized all initiation fee revenue over the initial period of membership. In 2004, Bally

acknowledged that the manner in which it implemented both the deferral method and the

modified cash method were improper and not in conformity with GAAP.

14. At least since 2000, Bally knew, or was reckless in not knowing, that its

accounting for initiation fee revenue was not in conformity with GAAP and caused its financial

statements to be misstated. As a result of Bally's premature recognition of initiation fee revenue,

Bally in its 2001 Form 10-K understated its accumulated deficit as of December 3 1,2001, by

$997.8 million -- nearly a billion dollars. Additionally, because Bally had already prematurely

recognized initiation fee revenue in prior periods, Bally in its 2002 Form 10-K was forced to

overstate its 2002 net loss before income tax by $54.2 million, and in its 2003 Form 10-K was

forced fiaudulently to overstate its 2003 net loss before income tax by $9.3 million.

Bally Fraudulently Overstated its Gross Revenue from "Prepaid Dues"

15. Bally also fiaudulently recognized revenue fiom "prepaid dues." Prepaid dues

revenue came about when a Bally health club member elected to renew his or her membership

for an additional period of time after completing the initial membership contract term. A

renewing member could elect to prepay his or her renewal dues. These prepayments were

referred to as prepaid dues.

16. GAAP required Bally to recognize prepaid dues revenue as monthly health club

services were provided. When dues were prepaid, the prepaid portion was to be deferred and

recognized as it was earned. From 1997 through 2003, however, Bally improperly accelerated

revenue from prepaid dues by recognizing as revenue the entire amount of the prepaid dues in

the month the payment was received, instead of recognizing it over the period for which that

member had prepaid.

17. Beginning in at least 2000, Bally knew that it was improperly accelerating

revenue from prepaid dues, but failed to assess the scope of the problem or to fix it. Eventually,

Bally publicly acknowledged "errors" regarding prepaid dues for prior periods. In its 2003 Form

10-K, Bally restated its prepaid dues revenue for prior periods going back to 1997 because, as the

company reported, its previous methodology resulted in "errors in calculating prepaid dues and r

accelerated dues recognition for certain prepaying members."

18. Bally knew, or was reckless in not knowing, that it was accounting for prepaid

dues revenue in a manner that was not in conformity with GAAP and caused Bally's financial

statements to be misstated. As a result of Bally's premature recognition of prepaid dues revenue,

Bally in its 2001 Form 10-K understated its accumulated deficit as of December 31,2001, by

$35 million. Further, Bally's premature recognition of prepaid dues caused it to overstate its

2001 net income before tax by $10.6 million in its 2001 Form 10-K and to understate its 2002

net loss before tax by $8.0 million in its 2002 Form 10-K.

Bally Fraudulently Overstated its Gross Revenue from "Reactivation Fees"

19. Bally also fraudulently recognized revenue from unpaid dues on inactive

memberships. Not all Bally members who completed their initial membership contract term

renewed their membership. Instead, they simply ceased paying dues. Those members who had

paid all amounts due under the initial membership contract, but who had then stopped paying

monthly dues for six months or longer were solicited by Bally for "reactivation." Bally's

"reactivation" offer permitted lapsed members to rejoin by paying a "reactivation fee," which

was lower than an "initiation fee."

20. GAAP prohibited Bally from recognizing any revenue fi-om "reactivation fees"

until after the reactivating members had entered into binding contracts. Rather than complying

with GAAP and waiting until Bally hadobtained customer acceptance and the reactivating

members had entered into binding contracts, Bally simply projected the number of reactivating

members that it anticipated rejoining up to three years into the future, and then recognized those

anticipated but hypothetical reactivation fees as revenue. Bally recognized that hypothetical

revenue over a period composed of (a) the average delinquent period (that is, the period between

when members stopped paying their monthly dues and when they reactivated) plus (b) the

average reactivation period.

21. In 2003, Bally abandoned this methodology and adopted a modified cash basis of

accounting for reactivation fees. Subsequently, in its 2004 Form 1 0-K, Bally acknowledged that

its prior accounting failed to comply with GAAP, admitting that "recording revenue associated

with anticipated reactivating members was contrary to GAAP requirements of a binding

agreement and customer acceptance." Bally also admitted that it "should have adopted the cash

basis for recoveries of unpaid dues on inactive memberships prior to 2003."

22. Bally knew, or was reckless in not knowing, that it was accounting for

reactivation fees in a manner that was not in conformity with GAAP and caused Bally's financial

statements to be misstated. As a result of Bally's premature recognition of reactivation fees, in

its 2001 Form 1 0-K, Bally understated its accumulated deficit as of December 3 1,2001, by

$2 1.8 million.

Bally Improperly Overstated its Gross Revenue from "Multiple Element Arrangements"

23. In addition to selling health club services, personal training services, and

nutritional products as separate services or products, Bally also sold packages that included a

combination of all three. In accounting terms, these packages are known as "multiple element

arrangements." GAAP requires that revenue from multiple elements be treated as a single

element unless it meets certain requirements which Bally did not meet.

24. During the relevant period, however, Bally failed to account for multiple element

arrangements in conformity with GAAP. Instead, Bally treated the sale of nutritional products,

the sale of personal training services, and the sale of membership contracts as separate elements

which allowed Bally to inappropriately prematurely record revenue. In 2004, Bally changed its

accounting method to treat the income from these arrangements as a single element and to

recognize the revenue from these arrangements on a straight line basis over the later of when r)

collected or earned.

25. As a result of Bally's premature recognition of revenue fiom multiple element

arrangements, in its 2001 Form 10-K, Bally understated its accumulated deficit as of

December 31,2001, by $105.5 million. Further, Bally understated its 2002 net loss before tax by

$86.5 million, and in its 2003 Form 10-K, understated its 2003 net loss before tax by

$33 million.

Bally Improperly Overstated its Gross Revenue from Prepaid Personal Training Services

26. In addition to selling health club memberships, Bally also sold personal training

services, that is, exercise sessions with personal trainers. Some customers prepaid for sessions

with personal trainers. GAAP requires that revenue from prepaid personal training services be

recognized only when earned; that is; when the personal training services were actually provided.

Bally, however, failed to account for prepaid personal training services revenue in conformity

with GAAP, and instead recognized revenue related to prepaid personal training services before

those services were actually provided. As a result of its premature recognition of prepaid

personal training services revenue, Bally in its 2002 Form 10-K understated its 2002 net loss

before income tax by $7.9 million, and in its 2003 Form 1 0-K, understated its 2003 net loss

before income tax by $4.6 million.

Bally Improperly Overstated its Gross ~ e v e n u efrom the Sale of Future Receivables

27. Finally, in addition to generating revenue from the sale of health club

memberships and related products, Bally also generated revenue selling future receivables.

GAAP required that sales of future receivables be treated as debt. During the relevant period,

however, Bally failed to comply with GAAP and instead accounted for sales of future

receivables as the sale of financial assets. This practice had the effect of prematurely

recognizing revenue from the sales of future receivables. As a result of adopting accounting for

revenue in conformity with GAAP, the company had to amend its accounting treatment of the

sale of receivables fiom the sale of financial assets to debt treatment. Bally's use of the non- .. -

GAAP accounting treatment caused in its 2002 Form 10-K to understate its 2002 net loss before

income tax by $281,000.

BALLY IMPROPERLY UNDERSTATED ITS EXPENSES

28. The accounting described above had the effect of overstating Bally's revenue

during the relevant period, and thus falsely improving Bally's publicly reported financial

performance. In addition, other accounting improprieties by Bally improperly improved Bally's

publicly reported financial performance by understating the expenses Bally incurred in operating

its chain of health clubs. Those expenses included the cost of paying interest on a bond issued

by a health club Bally acquired. Bally's expenses also included the costs of signing up new

members who visited Bally's facilities, such as sales people's salaries, as well as the costs of

advertising to attract potential new members to visit its facilities. Bally's expenses fkther

included the costs of leasing, operating, and maintaining hundreds of health clubs in the United

States and Canada, as well as the cost of acquiring or opening new clubs. Between 1997 and

2002, Bally focused on growing by acquiring already existing health clubs or by developing new

clubs. During that time, Bally bought or opened 152 new fitness centers.

29. As described below, Bally understated its expenses by a variety of means. It

understated one expense by failing to record a liability it in its public financial statements. It

understated certain other current expenses by treating them as capital assets, which enabled Bally

improperly to defer recognizing those expenses until years later and thus understate its current

expenses while providing Bally with a short-term boost to its financial statements.

Bally Fraudulently Capitalized and Deferred its "Membership Acquisition Costs"

30. In 1997, at the same time that Bally began fiaudulently to apply the deferral

method of accounting for "initiation fees," Bally also began fraudulently to account for so-called

"membership acquisition costs." "Membership acquisition costs" were supposed to be the costs

that would not have been incurred, but for entering into particular member agreements. Under

GAAP, costs that were directly related to the acquisition of a contract were required to be

capitalized and amortized as an expense over the same period that the deferred revenue from the

contract was recognized. All other costs were required to be charged to expense as incurred.

3 1. Notwithstanding GAAP, Bally deferred costs that were not directly related to the

acquisition of membership contracts. For example, Bally deferred 100% of its sales force's

salaries between 1997 and 2003, despite its failure to analyze the extent to which those salaries

related to successful sales efforts. During that same period, Bally also deferred as "membership

acquisition costs" 33% of all its Management Information Systems department's costs. It did so

even though its MIS department costs included such non-contract-acquisition items as

depreciation, repairs and maintenance, equipment rental, supplies, professional fees and utilities.

Bally also deferred as "membership acquisition costs" 100% (and later, 39%) of insufficient

funds charges, bank charges, and credit card charges during that same period.

32. Bally knew, or was reckless in not knowing, that its practice of deferring as

"membership acquisition costs" costs that were not directly related to the acquisition of

membership contracts failed to comply with GAAP and misstated Bally's financial statements.

This practice caused Bally in its 2001 Form 10-K to understate its accumulated deficit as of

December 31,2001, by $1 14million. It also caused Bally to understate in its 2002 Form 10-K

its 2002 expenses by $6.5 million, and to overstate in its 2003 Form 10-K its 2003 expenses by

$1 million.

Bally Improperly Understated its "Holiday Bonds" Expense

33. Bally understated its expenses by failing to include the interest expense associated

with a liability, the so-called Holiday bonds, in its public financial statements. As a result of

acquiring another health club, Holiday Health Clubs of Towson, in the late 1980s, Bally assumed

certain bonds that Holiday had issued to its members. Those bonds imposed on Bally a

$22 million face value repayment obligation, due in approximately 2015. When Bally acquired

Holiday, Bally added the Holiday bond liability to its balance sheet, and recognized an annual

interest expense associated with paying off the Holiday bonds. In 1995, however, Bally removed

the Holiday bond liability fiom its public accounting financial statements.

34. From 1995 to 2003, the Holiday bonds liability was not reflected on Bally's public

financial statements and Bally's public financial statements did not reflect any interest expense

related to Bally's obligation to repay the Holiday bonds. For tax purposes, however, Bally

continued to record the interest expense related to those bonds.

35. Bally's failure to reflect the Holiday bonds liability on its public financial

statements was not in conformity with GAAP and caused Bally's financial statements to be

misstated. As a result of Bally's omission of the Holiday bonds liability fiom its financial

statements, Bally in its 2002 Form 10-K understated its 2002 interest expense by $526,000, and

in its 2003 Form 10-K understated its 2003 interest expense by $589,000. Further, Bally's

failure to reflect the Holiday bond liability caused Bally's 2001 Form 10-K to understate its

accumulated deficit as of December 3 1,2001, by $4.3 million.

Bally Improperly Capitalized and Deferred its Advertising Expense

36. During the relevant period, Bally understated its advertising expense by .. -

improperly capitalizing rather than expensing, no later than the first time the advertising took

place, the costs of producing its advertisements. Specifically, Bally deferred recognizing the

production costs of its advertisements over the estimated life of the advertisements. This was not

in conformity with GAAP, and resulted in an understatement of advertising expense. As a result,

Bally's 2001 Form 10-K understated Bally's accumulated deficit as of December 31,2001, by

$3.3 million. Because Bally had understated its advertising expense in prior years, in its 2002

Form 10-K, Bally overstated its 2002 expenses by $525,000, and in its 2003 Form 10-K, Bally

overstated its 2003 expenses by $3.4 million.

Bally Improperly Understated the Expenses it Incurred in Acquiring Other Health Clubs

37, Between 1997 and 2002, Bally acquired a number of other health club companies.

Those business combinations were accounted for using the purchase method of accounting. The

purchase method of accounting required that the tangible assets and liabilities of the acquired

company be recorded on Bally's books at fair market value. If the purchase price for the

acquired business exceeded the net fair market value of the acquired business's tangible assets

and liabilities, then that excess purchase price was to be attributed in the first instance to

identifiable intangible assets, such as existing customer relationships, trademarks, and non-

competition agreements. Any remaining excess purchase price was to be attributed to the

unidentified intangible asset, commonly known as "goodwill."

38. At the beginning of the relevant period, GAAP required that goodwill be

amortized -- that is, removed fkom the balance sheet and moved to the income statement as an

expense -- over the useful life of the goodwill, which could not exceed 40 years. During the

relevant period, GAAP's treatment of goodwill changed. Goodwill was no longer required to be

amortized; instead, companies having goodwill on their books were required to conduct a

periodic "impairment analysis." - The "impairment analysist' tested whether the goodwill's fair

value continued to match its carrying amount, or book value. If the analysis concluded that the

fair value of the goodwill no longer matched its book value, then the goodwill's book value was

written down to reflect the fair value determined by the impairment analysis. The difference

between book value and fair value was expensed.

39. Bally's application of the purchase method of accounting failed to conform with

GAAP in at least two ways. First, prior to the release of its 2004 Form 10-K, Bally's method of

allocating the purchase prices of acquired businesses failed to comply with GAAP and resulted

in an overstatement of goodwill and corresponding understatement of expense. This is because

Bally failed properly to allocate a portion of the purchase price to certain separately identifiable

intangible assets, namely, "Membership Relations," "Non-compete Agreements," "Trade Name,"

and "Leasehold Rights." Second, Bally's method of amortizing goodwill, and later conducting

(or failing to conduct) impairment analyses, also failed to comply with GAAP and resulted in an

overstatement of goodwill and a corresponding understatement of expense.

40. As a result of Bally's improper application of GAAP to its goodwill, Bally in its

2002 Form 10-K understated its 2002 expenses by $14.1 million, and in its 2003 Form 1 0-K,

understated its 2003 expenses by $60.9 million.

Bally Improperly Understated its Lease Expenses

41. Bally leased rather than owned numerous of its facilities, and during the relevant

period, Bally's lease accounting was not in conformity with GAAP for a variety of reasons.

First, Bally improperly failed to recognize rent expense on club leases with escalating rental

obligations using the required straight-line rent method. Second, Bally improperly reflected

tenant allowances as a reduction of property and equipment on the balance sheet and improperly

amortized these amounts and the related leasehold improvements to depreciation expense. Third,

Bally improperly reflected tenant allowances as a component of cash flows fiom investing

14

activities in its statement of cash flows. Fourth, Bally improperly failed to depreciate leasehold

improvements over the lesser of the asset's economic life, with a maximum of fifteen years, or

the contractual term of the lease, excluding all renewal options. As a result of Bally's improper

application of GAAP to its lease obligations, Bally in its 2002 Form 10-K understated its 2002

expenses by $13.9 million, and in its 2003 Form 10-K, understated its 2003 expenses by $1 1.4

million.

Bally Improperly Deferred the Costs it Incurred in Building out its Health Clubs

42. During the relevant period, various Bally clubs were temporarily closed while

Bally undertook construction in preparation for use by members. Although the clubs were

closed, Bally nonetheless incurred rent costs during the construction periods (so-called "presale

costs"). Under GAAP, presale costs are to be recognized as expense when incurred unless

certain requirements are met. Bally failed to meet those requirements, but nonetheless

improperly deferred recognition of presale costs. As a result, Bally in its 2002 Form 10-K

understated its 2002 expenses by $2.3 million, and in its 2003 Form 10-K, understated its 2003

expenses by $967,000.

43. In addition to incurring rent while clubs were closed for remodeling and

construction, Bally also incurred certain internal compensation costs ("capitalized maintenance

costs"). Although GAAP required that these costs be recorded as expense when services were

rendered, Bally improperly capitalized and deferred these costs and recognized them as expense

' in later periods. As a result, Bally in its 2002 Form 10-K understated its 2002 expenses by $3.5

million, and in its 2003 Form 10-K, overstated its 2003 expenses by $3.0 million.

Bally Improperly Failed to Record Expenses Associated with its Assets

44. During the relevant period, Bally improperly failed to account for its fixed assets

in conformity with GAAJ?. GAAJ? required that Bally periodically analyze whether its fmed

assets' value had been impaired by certain kinds of events, and if so, to recognize the amount of

impairment as an expense. Bally, however, failed to identify the existence of events that should

trigger an asset impairment analysis, and failed to measure the related impairment charges. As a

result, Bally in its 2002 Form 10-K understated its 2002 expenses by $766,000, and in its

2003 Form 10-K, understated its 2003 expenses by $5.2 million.

45. Similarly, during the relevant period, Bally improperly failed to account for its

long-lived assets apart fkom goodwill and fixed assets in conformity with GAAP. As a result,

Bally in its 2002 Fonn 10-K understated its 2002 expenses by $600,000, and in its 2003 Form

10-K, understated its 2003 expenses by $2.2 million.

-Bally Improperly Accounted for its

Exercise Equipment Inventory Expense

46. During the relevant period, Bally's method of accounting for equipment trade-ins

failed to comply with GAAP and resulted in an overstatement of the cost basis and resulting

aggregate depreciation expense for Bally's investment in exercise equipment. As a result, Bally

in its 2002 Form 10-K understated its 2002 depreciation expense by $1.1 million, and in its 2003

Form 10-K, overstated its 2003 depreciation expense by $1.6 million.

Bally Improperly Accounted for its Deferred IT Services Expense

47. During the relevant period, Bally's method of accounting for the internal and

external costs it incurred in developing internal-use computer software failed to comply with

GAAP. Instead, Bally improperly deferred recognition of those expenses. As a result, Bally in

16

its 2002 Form 10-K understated its 2002 expenses by $2.2 million, and in its 2003 Form 10-K,

understated its 2003 expenses by $424,000.

Bally Improperly Accounted for its Self-insurance Expenses

48. During the relevant period, Bally self-insured itself against workers'

compensation, health, life, and general insurance claims. Bally's methodologies for estimating

those claims, however, resulted in an understatement of Bally's expenses relating to its

self-insurance liabilities. As a result, Bally in its 2002 Form 10-K understated its 2002 expenses

by $3.9 million, and in its 2003 Form 10-K, overstated its 2003 expenses by $2.8 million.

Bally Improperly Understated its Escheatment Obligations

49. During the relevant period, Bally understated its liability for the potential

escheatrnent of payroll-related and supplier-related checks. As a result, Bally in its 2002 Form

10-K understated its 2002 expenses by $610,000, and in its 2003 Form 10-K, understated its

2003 expenses by $1.2 million.

Bally Improperly Failed to Expense Other Costs

50. In addition to the instances described above, Bally also understated its expenses

by capitalizing various other costs, none of which was individually significant, but which GAAP

required to have been recognized as expenses when they were incurred. This improper

capitalization of expenses caused Bally in its 2001 Form 10-K to understate its accumulated

deficit as of December 3 1,2001, by $8.0 million. Additionally, it caused Bally in its 2002 Form

10-K to understate its 2002 expenses by $442,000, and in its 2003 Form 10-K, to overstate its

2003 expenses by $2.8 million.

BALLY IMPROPERLY UNDERSTATED ITS ACCUMULATED DEFICIT

5 1. Bally engaged in other accounting improprieties that resulted in it understating its

accumulated deficit, and thus materially overstating its net worth.

Bally Improperly Accounted for Gains and Losses from its Canadian Operations

52. During the relevant period, Bally operated health clubs in Canada. Bally failed

properly to account for changes in currency exchange rates in determining gains and losses

resulting from transactions in Canada. This caused Bally in its 2001 Form 10-K to understate its

accumulated deficit as of December 3 1,2001, by $2.3 million. It also caused Bally in its 2002

Form 10-K to fail to report gains of $1.7 million in 2002, and in its 2003 Form 10-K, to fail to

report gains of $2.4 million in 2003.

Bally Improperly Overstated the Value of its Retail Inventory

53. During the relevant period, Bally overstated the value of its retail inventories,

primarily as a result of (a) differences in physical count and (b) incorrect accounting for cost of

goods sold. As a result, Bally in its 2001 Form 10-K understated its accumulated deficit as of

December 3 1,2001, by $2.2' million; in its 2002 Form 1 0-K, overstated its 2002 expenses by

$538,000; and in its 2003 Form 10-K, understated its 2003 expenses by $594,000.

Bally Failed Properly to Record its Period-end Accruals '

54. During the relevant period, Bally also failed to properly accrue certain obligations

at the end of its accounting periods. This caused Bally in its 2001 Form 10-K to understate its

accumulated deficit as of December 31,2001, by $4.1 million. It also caused Bally in its 2002

Form 10-K to understate its 2002 expenses by $519,000, and in its 2003 Form 10-K to understate

its 2003 expenses by $259,000.

18

Bally's Miscellaneous Other Failures to Conform to GAAP

55. As Bally acknowledged in the restatement contained in its 2004 Form 10-K, Bally

also failed to comply with GAAP in connection with a number of other items during the relevant

period, none of which were individually significant. This caused Bally in its 2001 Form 10-K to

understate its accumulated deficit as of December 31,2001, by $9.6 million. It also caused Bally

in its 2002 F o m 10-K to understate its 2002 income before taxes by $2.5 million, and in its 2003

Form 10-K, to understate its 2003 income before taxes by $4.4 million.

FIRST CLAIM FOR RELIEF

Fraud Violations of Section 17(a) of the Securities Act [15 U.S.C. 3 77q(a)],

Section 10(b) of the Exchange Act [15 U.S.C. § 78j(b)], and Exchange Act Rule lob-5 [17 C.F.R. § 240.10b-51

56. Paragraphs 1 through 22 and paragraphs 30 through 32 are re-alleged and

incorporated by reference.

57. By reason of the foregoing, defendant directly or indirectly, knowingly or

recklessly, by use of the means or instnunentalities of interstate commerce or of the mails, in

connection with the offer, sale, or purchase of securities: (a) employed devices, schemes or

artifices to defiaud; (b) made untrue statements of material fact or omitted to state a material fact

necessary to make the statements made, in the light of the circumstances under which they were

made, not misleadihg; (c) obtained money or property by means of any untrue statement of a

material fact or any omission of a material fact necessary in order to make the statements made,

in light of the circumstances under which they were made, not misleading; or (d) engaged in

transactions, acts, practices, or courses of business which operated as a fraud or deceit upon other

persons.

58. By reason of the foregoing, defendant violated, and unless restrained will violate,

Section 17(a) of the Securities Act, section lo@) of the Exchange Act, and Exchange Act

Rule lob-5.

SECOND CLAIM FOR RELIEF

Reporting Violations of Section 13(a) of the Exchange Act [15 U.S.C. § 78m(a)]

and Exchange Act Rules 12b-20,13a-1,13a-11, and 13a-13 [17 C.F.R §§ 240.12b-20,240.13a-1,240.13a-11 & 240.13a-131

Paragraphs 1 through 55 are re-alleged and incorporated by reference.

59. The Exchange Act and rules promulgated thereunder require every issuer of a

registered security to file reports with the SEC that accurately reflect the issuer's financial

performance and provide other true and accurate information to the public. In addition to the

materially inaccurate Forms 10-K identified above, during the relevant period, Bally also filed

materially inaccurate Forms 10-Q and 8-K.

60. By reason of the foregoing, defendant violated, and unless restrained will violate,

violations of Section 13(a) of the Exchange Act and Rules 12b-20, 13a-1, 13a-11, and 13a-13

thereunder.

THIRD CLAIM FOR RELIEF

Record Keeping and Internal Controls Violations of Sections 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act

[15 U.S.C. § 78m(b)(2)(A) and 78m(b)(2)(B)]

61. Paragraphs 1 through 55 are re-alleged and incorporated by reference.

The Exchange Act and rules promulgated thereunder require each issuer of registered securities:

(a) to make and keep books, records, and accounts which, in reasonable detail, accurately and

fairly reflect the business of the issuer; and (b) to devise and maintain a system of internal

controls sufficient to provide reasonable assurances that, among other things, transactions are

recorded as necessary to permit preparation of financial statements in conformity with GAAP or

any other criteria.

62. By reason of the foregoing, defendant violated, and unless restrained will violate,

Sections 1 3(b)(2)(A) and 13(b)(2)@) of the Exchange Act.

PRAYER FOR RELIEF

WHEREFORE, the SEC respectfully requests that this Court enter a final judgment:

(a) permanently enjoining defendant fiom violating Section 17(a) of the Securities

Act, Sections 1 O(b), 13(a), 13(b)(2)(A) and 13(b)(2)(l3) of the Exchange Act, and

Exchange Act Rules lob-5,12b-20,13a-1, 13a-11, and 13a-13; and

(b) granting such other relief as this Court may deem just and appropriate.

Dated: February 28,2008

Washington, D.C.

By: Alan M. Lieberman Robert E. Leidenheimer, Jr. U.S. Securities & Exchange Commission 100 F. Street, N.E. Washington, D.C. 20549 Tel.: 202-55 1-4474 (Lieberman) Fax: 202-9 (Lieberman) Email: LieberrnanA@,sec.gov

Of Counsel:

Fredric D. Firestone Kenneth R. Lench David Kagan-Kans